Taking money from a pension without paying Income Tax can be appealing, especially if you have a mortgage to clear, family to support, or retirement plans. But tax treatment alone doesn’t tell you whether to take it now, how much to withdraw, or which pension to use.
Where you have substantial pensions alongside cash, investments and property, the decision needs to account for those resources together. Taking tax-free cash may serve a clear purpose, while withdrawing the maximum without a plan could reduce the pension funds available for later needs.
Start with what you want the money to achieve.
Establish what you can take
With a defined contribution pension, a pot built from contributions and investment returns, you can usually take up to 25% of the benefits as tax-free cash.
For most people, the standard Lump Sum Allowance is £268,275 across all pensions, rather than a separate allowance for each pot. Protected entitlements may allow more, while benefits already taken can reduce what remains available. Withdrawals made before April 2024 may require calculations under transitional rules.
These limits matter for larger pensions because a substantial pot does not necessarily mean you can withdraw a quarter of its value tax-free.
Defined benefit pensions, such as final salary schemes, require a different assessment. Depending on the scheme, taking a lump sum may involve giving up some guaranteed annual income. The scheme’s quotation should show that trade-off before you decide.
Give the withdrawal a purpose
A specific use helps establish both the amount needed and the timing. You might be considering:
- Repaying a mortgage or other borrowing.
- Funding a property purchase or improvements.
- Helping children or grandchildren.
- Supplementing income while reducing work.
Each involves different considerations. Repaying borrowing means weighing the interest saved against the impact on accessible capital and future pension income. A family gift also needs to be weighed against your spending plans and estate objectives.
If you don’t need the money immediately, consider what changes once it leaves the pension. Cash held personally may earn interest, but that interest can be taxable depending on your circumstances. Investment returns outside a pension or ISA may also be taxable.
Leaving money invested carries its own risks: values can fall, and growth isn’t guaranteed. The decision should reflect when you’ll need the money and how you invest it, rather than assuming either withdrawing or waiting is always better.
Compare the other resources available
Your pension may be only one funding source: cash savings, ISAs, and other investments could cover the same expense, but each has different consequences.
Spending cash might reduce the reserve you want for unexpected costs. Drawing from an ISA could reduce assets available for future tax-free withdrawals. Selling other investments may create a Capital Gains Tax liability.
The comparison should also account for ownership. In a couple, assets and pension entitlements may be distributed unevenly, with different income needs and tax positions.
A financial plan can examine these choices together, including how much accessible capital remains afterwards. The lowest immediate tax bill is one consideration alongside future income, investment risk and the flexibility to respond to changing circumstances.
You may be able to take cash in stages
Accessing tax-free cash does not necessarily require taking the full entitlement at once.
With phased drawdown, you can access portions of your pension over time, usually taking up to 25% of each portion tax-free, subject to available allowances. The remaining 75% can stay invested in drawdown until you choose to withdraw taxable income.
Alternatively, you can take lump sums directly from pension funds you haven’t accessed yet. Known as uncrystallised funds pension lump sums, these normally pay 25% of each withdrawal tax-free, while the remaining 75% is taxable income at that point. The difference is that each payment includes both elements, rather than allowing you to take tax-free cash and leave the taxable portion invested.
For someone still contributing, the distinction matters most. Taking only a pension commencement lump sum does not itself trigger the Money Purchase Annual Allowance. Taking taxable income through flexible drawdown or using the second method normally does. This sets a £10,000 annual limit on defined contribution pension saving before an annual allowance tax charge may apply, including employer contributions.
An illustration: funding a family gift
Consider someone aged 60 who is still working and wants to provide £100,000 towards their daughter’s home. They have a £1.2 million defined contribution pension, cash savings, ISAs and other investments.
This is a hypothetical illustration, rather than a Stratton client case study.
A quarter of the £1.2 million pension is £300,000, exceeding the standard £268,275 allowance. Assuming no protected entitlement or prior use of the allowance, the standard limit would apply. However, their immediate requirement is £100,000.
The useful comparison is between ways of funding that amount. Would using cash leave an adequate reserve? Would investment sales create a tax bill? Could a partial pension withdrawal meet the need while preserving future options?
Because they are still working, the withdrawal method also needs to be checked against ongoing pension contributions. Cashflow modelling could then assess the gift alongside future retirement spending, using assumptions that are reviewed rather than treated as guarantees.
That gives the decision a practical basis: the amount needed, the resources remaining and the implications for later plans.
Review the estate-planning assumptions too
Pensions have often been retained partly because of their treatment on death. That reasoning needs revisiting as the rules change.
From 6 April 2027, most unused pension funds and pension death benefits will be included in the estate for Inheritance Tax purposes. Existing exemptions for benefits passing to a surviving spouse or civil partner will remain.
This does not automatically make withdrawing tax-free cash the better choice. Money you take out and keep personally may still form part of the estate. Giving it away introduces separate gifting rules and reduces the resources available for your own needs.
The assessment therefore needs to consider intended beneficiaries, potential taxes, future spending, and whether you will spend, retain, or gift any money withdrawn. A plan based on earlier pension rules should be reviewed before acting.
Bring the decision into your wider plan
Before requesting a lump sum, establish how much tax-free entitlement remains, what the money is for and how the withdrawal compares with other funding options.
If family support or estate planning is involved, you may also need input from an accountant, tax adviser, or solicitor. Stratton’s approach brings that advice together with financial planning, so the pension decision reflects your wider priorities.
To discuss how taking tax-free pension cash would fit your plans, speak to Stratton.
This article provides general information and is not personal financial or tax advice. Pension and investment values can fall as well as rise. Tax treatment depends on individual circumstances, and rules may change.
